What is the digital dollar and what does it mean for privacy and banking?

As fewer consumers regularly use cash and more countries adopt the virtual currency, the Federal Reserve Bank of New York and several other major banks launched a 12-week pilot program last month to test the use of the digital dollar. But some experts and activists question whether the digital currency will live up to its potential, such as making banking more accessible.

The program is the latest step by the central bank to begin its investment. This effort also follows the introduction of the eCash Act in March by US Representative Stephen Lynch. The bill, sponsored by three other Democratic lawmakers but not passed by either chamber, calls on the Treasury Department to take action. Investment in government-issued digital currency.

“The reality is that cash, that is, physical currency, is being phased out in almost every economy in some countries… The use of cash is already declining, and I doubt the day will come when even the US will no longer use cash. anymore,” said Eswar Prasad, a professor of trade policy at Cornell University.

WATCH: The US-backed digital currency can live alongside certain cryptocurrencies

Using digital tokens that represent customer deposits, the pilot will test how those tokens are “redeemed” through a central bank using a ledger shared by institutions.

When used correctly, a central bank’s digital currency can make money transfers easier and lower costs for individuals and businesses, especially for people who can’t afford to use traditional commercial banks. But it can also become a privacy threat, experts say.

Digital currencies, once an obscure part of financial technology, have become more mainstream in the past five years, particularly as interest in the cryptocurrency Bitcoin has grown. Cryptocurrencies have offered payment methods outside of formal banking systems, but interest has risen as they have also become the subject of financial speculation, making fortunes quickly won and lost far more easily. When the cryptocurrency exchange collapsed last month, regular customers were unable to withdraw their funds, prompting investigations by the SEC, the US Attorney’s Office in New York and Congress, and charges against former CEO Sam Bankman-Fried.

WATCH: Implications of the FTX Collapse on the Cryptocurrency Industry

Central bank digital currencies like the Federal Reserve differ from cryptocurrencies in important ways. Many cryptocurrencies can be generated by anyone who can “mine” the currency by using computers to solve complex equations. But central bank digital currency is issued and backed by, you guessed it, a central bank, just like hard currency.

As cash is replaced by digital transactions in many settings, Prasad said the central bank’s question “then becomes whether it will maintain the viability of its money at the retail level by issuing a digital form of its currency.”

Digital currencies have been launched or are being tested by at least 15 central banks, including China, Canada and Jamaica, for various reasons. China, which began piloting its digital currency in 2020, expanded the digital yuan ahead of the 2022 Winter Olympics. According to some experts, the digital yuan could create an international currency to compete with the dollar, as well as create a payment system similar to Chinese companies such as WeChat or AliPay. The Eastern Caribbean Reserve Bank, which is unique in that it issues a foreign currency for eight countries, has created a digital currency designed to ease cross-border transaction costs and provide financial services to the unbanked.

Prasad said a central bank digital currency (CBDC) could help unbanked people access financial services, including cashless payments.

“CBDC can fill that gap and can also create more competition, which can reduce the cost of digital payments in the US and provide alternatives,” Prasad said.

More affordable banking?

4.5 percent of U.S. households are “unbanked” (meaning no one in the household has a bank account), according to the FDIC’s 2021 report. Black Americans, Latinos, and poorer people are more likely to be unbanked. The most common reason was that no one in the household had sufficient funds to meet the minimum deposit requirements. Because digital payment systems such as Venmo or Apple Pay require the use of bank accounts or credit cards, people who do not have these financial services cannot use such payment systems either.

Services often used by the unbanked, such as payday lending, have largely moved online as well, said Mario Small, professor of social sciences at Columbia University.

“In this space, you can imagine that creating a central bank digital currency, as opposed to something like bitcoin, could have a positive impact,” Small said.

But Small warns that new payment services, such as the digital dollar, may also simply recreate existing financial services inequities.

“I think the devil is going to be in the details,” Small said. “My expectation would be that the people adopting digital currencies will be people who are already well connected to both online financial services and banking. And so it’s possible that if we’re not careful how we go about it, it’s just going to exacerbate the inequalities that already exist.”

READ MORE: Treasury recommends exploring central bank creation of digital dollar

Some central banks, including China’s, have created digital wallets that allow customers to hold bank-issued digital currency. But the US Federal Reserve is unlikely to work directly with customers. According to the Treasury’s Future of Money report released in September, allowing customers to hold digital currency with the Reserve Bank is one, although a “more feasible model” is a two-tier system using intermediaries such as private banks. issue digital currency to customers.

“I think the Fed doesn’t want to be in a position and no central bank really wants to be in a position to start taking deposits,” Prasad said.

Prasad said taking deposits would push the Federal Reserve to lend as well, positioning itself as a potential competitive threat to commercial banks.

“No central bank really wants to create a threat to the commercial banking system, because commercial banks are very important in creating credit in the economy. So I think from a central bank perspective, I think the do-no-harm objective will work here,” he said.

But he suggested the government could require commercial banks to offer low- or no-fee services to customers making small digital currency transactions, something other countries that have launched digital currencies have already begun to explore.

John Jay College of Criminal Justice Associate Professor of Economics J. V.

READ MORE: Millions of “unbanked” Americans lack adequate access to financial services

That notion “has been used to justify the Fed’s entry into this world of exciting, cool new technology that has a lot of people excited but really has little to do with the problems that have been identified.” Mason said.

“There is a real problem to be solved there. But you don’t really need a new currency.”

Mason said regulatory changes, such as allowing the post office to offer banking services again or capping fees charged by commercial banks, would be a better way to help the unbanked.

“You know, we can regulate the banks. That’s something we can do,” Mason said.

Privacy Concerns or Protections?

There are also potential privacy issues with digital currency. USD can be used as cash without monitoring. Digital payment systems like apps and credit cards leave records, and the digital dollar is likely to leave a similar trail.

“This could go either way dramatically in terms of our privacy rights,” said Leah Holland of digital rights group Fight for the Future.

READ MORE: Federal Reserve Report on Digital Currency Centers at Banks

Currently, payment apps like Venmo or Cashapp can collect data about what kinds of purchases you make, which can be shared with third parties, often for marketing purposes. Retailers also typically target specific consumers through online shopping, social media, and loyalty programs. When it comes to the US government, the Treasury Department monitors transactions it suspects are related to terrorist activity, while the IRS requires taxpayers to fill out a special form if they receive more than $10,000 in a single or related transaction from financial crimes. for protection.

Prasad agreed that privacy could be a concern for the digital dollar, and said the collection of user data was one reason the Chinese government wanted to issue its own digital currency rather than let the field be controlled by private companies.

There, private companies providing digital transactions were “collecting vast troves of data that until recently they were unwilling to share with the government,” Prasad said.

On the other hand, Holland said, a privacy-friendly digital dollar that doesn’t try to profit by using information about your financial behavior will fare better than other payment services.

“The digital dollar could serve as a return to privacy,” Holland said.

Some lawmakers have taken note of these discussions. The proposed eCash bill called on the Treasury Department to pursue a digital currency “that replicates and serves the privacy, anonymity, and minimal transaction data generation properties of physical currency” and serves people who have been unable to afford traditional currency. : financial services such as banks.

Despite the (unfulfilled) efforts of Congress to protect consumer privacy, Holland said, “the ability to monitor digital transactions is incredibly tempting for legislators and legislators. And so for them to actually create a rights-preserving digital dollar, it’s going to be an uphill battle.”

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top